Vigilant Investments Advisors, LLC.

The Virtue of the Economic Cycle

Recently I have been asked about the economic crisis and whether I believe that the response from the government will be effective in fixing the crisis.  The challenge in answering the question almost makes it an inappropriate question with no simple answer.  At this point it is clear that the managers of Monetary and Fiscal Policy are going to do everything they can, including printing new money, to turn the economy around; the problem is that they can only turn it around temporarily.

Capitalism, by its nature has periods of economic boom and economic bust known as the economic cycle.  These cycles are very difficult to eliminate and efforts to eliminate the economic cycle from an economy founded on capitalism are, by their nature, counter to the principles of capitalism.

Spending time with someone who lived through the Great Depression of the 1930’s is a fascinating window into capitalism’s reality.  For those who lived through the 1930’s, being frugal is a long-term way of life, debt is akin to a sin and any opportunity to save for a rainy day should be seized with both hands.

The virtue of the economic cycle is that during times of economic bust, hard lessons are taught about debt, savings and finding meaningful employment.  If, over a generation or two, those lessons are not taught, the average participant in a capitalistic economy behaves differently than they should in order to make the system continue.

For example, the economically unlearned may begin to borrow to make purchases in the hope that they can afford the items in the future.  They may begin to be less productive in their employment and, at the same time, more expectant of their employer.  They may begin to expect more from their government than the government is able to provide.  And, they will continue to save less and less for a rainy day because the only rainy day they know about isn’t really so bad.

Unfortunately, at the end of 2008, this sounds a little too close to home for most Americans.  Because the virtues of a capitalist economy were never truly taught, the unfortunate mis-behavior is to be expected.   The solution to this current problem is for people to learn the difficult lessons as quickly as possible—unfortunately, I don’t believe this will happen.

The Government response to the problem will continue to reinforce the belief that the rainy days really aren’t all that rainy and that the lack of savings and extraordinary levels of debt weren’t that difficult unwind.  The unintended consequences of the policy response may be worse in the long run.  The long run in this economic environment may only be a short run cycle of three to five years before the next wave of economic bust.  Will the government be able to save us then?

In times like these, those individuals and companies that have reduced or eliminated debt and saved for a rainy day will survive while those around them will fall.  It seems that in today’s world economy, the best competitive tactic may just be to live to fight another day.